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Equity rally sucks value out of investment trusts

Falling discounts mean bargain hunters may now have to look elsewhere to snap up undervalued investments.

Thomas McMahon

By Thomas McMahon, Reporter, FE Trustnet
Friday March 01, 2013

Discounts have closed on investment trusts across the board in recent weeks, as the market rally has increased the popularity of equities and other riskier assets.

Sectors that FE Trustnet reported to be rated as cheap buys by brokers at the end of last year – private equity, smaller companies and Europe – have all seen discounts narrow, meaning there is little value for bargain hunters in these sectors.

Analysts recommend waiting for discounts to widen or switching to a long-term buy-and-hold strategy of the sort more likely to be adopted by ISA investors.

Kieran Drake, analyst at Winterflood Securities, said: "For a while, private equity was our favourite, but discounts have started to come back in."

"In general, discounts have tightened across the board and you tend to get that effect in market rallies. I don’t think there’s anything that’s looking unusually cheap."

Oriel Securities downgraded a whole swathe of the biggest trusts in the private equity sector this week following stunning share-price gains.

Data from FE Analytics shows that 3i Group has risen 47.51 per cent since 1 January, while Candover Investments is up 28.2 per cent and Electra Private Equity 18.52 per cent.

Performance of trusts in 2013


Source: FE Analytics

FE Trustnet highlighted the Private Equity sector as a bargain area set for a rally back in November 2012.

The rise in the price of 3i is partly down to the growing involvement of activist investor Sherbourne Group, which many commentators believe could be planning a takeover bid.

Oriel rates 3i as a sell, and its two peers a hold, downgraded from buys.

Drake explains that in the UK Smaller Companies sector, discounts are now at the narrow end of their 12-month range.

"They might look wide compared to other sectors, but compared to history they are not," he said.

"The discounts have tightened a bit and most of them are lower than their 12-month average."

One of the reasons for the larger average discounts on smaller companies is the involvement of large institutional shareholders who sell quickly after discounts narrow.

Drake also says that European trusts no longer look cheap, now that many investors have started to dip their toes back into the water.

This leaves investors with two main tactical options.

"Those who play discounts might want to wait until they move out again, but the trouble is you don’t know how long the rally will be," Drake said.

"You can play the discount, but you may end up waiting a long time and missing out on the NAV rise."

"It depends on what basis you are investing, however. Perhaps you don’t want to tinker around with discounts and you are looking at what the underlying managers are doing and the prospects for the fund."

In this case Drake says investors should look at which managers and trusts are set to do well over the long run, and should be willing to pay a small premium for this if necessary.

He picked three such trusts that Winterflood recommends.

Personal Assets Trust

"This is quite a defensive portfolio at the moment, but it has got a good long-term performance record."

"In 2008 it was able to protect capital pretty well and that’s one of its primary objectives as well as growth."

"It has a zero-discount policy as well, so you are protected from any discount widening as they buy back shares."

Sebastian Lyon’s £543m trust is often praised by analysts for its steady track record since he took over.

It has made 35.08 per cent in share price terms over the past three years while the FTSE All Share has made 35.51 per cent, but at less than half the volatility.

Until very recently it had outperformed the index, but its cautious, mixed-asset approach has seen it lag since markets started to rise at the end of last year.

Performance of trust vs benchmark over 3yrs


Source: FE Analytics

Although it is currently on a premium of 1.6 per cent, according to the AIC, the board has a policy of constantly issuing shares to bring it down to zero. The total expense ratio (TER) on the trust is 1.01 per cent.

JPMorgan Global Emerging Markets Income Trust

"One we like for a bit more risk is JPMorgan Global Emerging Markets Income Trust, which is quite popular right now thanks to people wanting income and access to emerging market growth as well."

It trades on a slight premium, which is currently 2.5 per cent, and has a 3.7 per cent yield.

Data from FE Analytics shows it has made 39.35 per cent since launch in 2011, while the MSCI Emerging Markets index has made 15.84 per cent.

Performance of trust vs benchmark since launch


Source: FE Analytics

"It was launched in 2011 so it does have some history, but is relatively new and has been one of the best performers in its emerging market peer group," Drake said.

"Income stocks have had a good run, but the theory is that investing in emerging market companies that pay dividends will prove less volatile."

The trust is expensive, with a TER of 2.83 per cent last year inclusive of a performance fee.

Scottish Mortgage IT

"It’s a global fund that can have volatile performance in the short-term. It’s not constrained by any benchmark, so do not expect it to perform in line with indices," Drake said.

"Over the long-term its prospects could be good."

The £2.1bn trust is managed by James Anderson at Baillie Gifford and has one of the very best long-term track records of global growth trusts, having made 346.76 per cent over the past decade.

Over the past year it is up 2.52 per cent while the FTSE All World has made 14.62 per cent.

The trust is sitting on a discount of 4.5 per cent and has a TER of just 0.51 per cent.

This article is for professional investors only. You will be redirected to the News & Research homepage in seconds. If you are having problems getting to the page, please click here
Data provided by FE. Care has been taken to ensure that the information is correct, but FE neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.

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